How good is good management?

28th July 2011

If so, any business that makes big profits must have quality management, with the biggest profits meaning the very best management.

Consider merchant banks. If they take one quarter of one per cent on each deal, and the deals are big enough, they'll make millions every day. By contrast, a great manager in an NHS trust might save £250,000 and 10 lives a year on a budget of £5 million – a huge financial return when making money isn't the major goal anyway. Another manager in another organisation handling several billion and only making half a percent when, on average, they should make 2 per cent still makes millions in profit and is paid accordingly – but the performance is actually worse compared to a "par score".

We don't pay the person who cleans the toilets in a premier league football ground or a merchant bank 1,000 times what we pay the person who cleans the toilets in a NHS trust just because the football club (or any other business) handles a lot of money each day. So why do we pay a financial manager in a business 1,000 times what we pay a NHS financial manager because they play with more money, irrespective of their performance relative to their peers?

Likewise, should the Chancellor be paid millions because the company (UK plc) makes billions every day and he could therefore claim to be a great manager?

If earnings are based on the "top" person actually producing more than others doing the same job in the same conditions, they might justify being paid in proportion to the extra they bring in. But that would be by contrast to the "next best" – not in comparison to what anybody could make given that they are going to get a share of huge sums only because they happen to be involved with huge sums.

The problem then becomes – how can we measure the top performers compared to the next person?

People have trouble distinguishing between luck and skill.

Making successful takeovers, managing funds well, etc, may be very clever and, viewed beforehand, very unlikely. So is winning the lottery. But somebody, out of the millions who play, often wins.  The odds of one particular person achieving something unlikely may be a million to one in advance, but the odds of somebody doing it out of the millions who try amount almost to certainty. 

The odds of beating the stock market index 10 years in a row are, basically, 1 in 1,024 (an even chance each year, for 10 years). It is unlikely and therefore any investor or fund manager who does it is regarded as brilliant. But as there are over 6,000 funds and millions of investors, you'd expect a few to do it by chance, and there are actually less "winners" than chance would predict given the number of attempts.

Of course, some managers do perform well over a period. Gordon Brown had Fred Goodwin knighted, and voted European Banker of the Year.  Nobody said – "he's been lucky so far, he's taking too many risks, he's greedy and pushing his luck". Everybody said he was a genius. And three years later Gordon Brown and everybody else said that he'd taken too many risks, he was greedy, stupid etc.

It is easy to be wise after the event. But how do you know whether somebody is just lucky or really skilful and how do you know they are so much more skilful than the next best person?

The problem is exacerbated by the cult of the "Great Leader".  The successful business leader makes huge profits, therefore in their own eyes they are great, therefore they can't be lucky but must be the most skilled, therefore anybody challenging them must be an idiot. So they don't listen to criticism or different interpretations of risk, because it only comes from idiots, anybody intelligent will bow down and worship them. It is the standard human failing of overconfidence, magnified by the fact that they think that because they are a Great Leader they must be special and not lucky. And the confirmation that they are Great is that they are paid huge amounts of money, so they must be the best manager, mustn't they?

In considering performance it's useful to consider:

More from Kim on Mindful Money:

Finding an honest advisor needs an honest approach from investors

Why a great leader doesn't always make for a great business.

Financial regulation: Why bother at all?

The fairer sex? When it comes to business men and women are created equal

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